Economics of Competition in the U.S. Livestock Industry Clement E. Ward, Professor Emeritus Department of Agricultural Economics Oklahoma State University January 2010 Paper Background and Objectives Questions of market structure changes, their causes, and impacts for pricing and competition have been focus areas for the author over his entire 35-year career (1974-2009). Pricing and competition are highly emotional issues to many and focusing on factual, objective economic analyses is critical. This paper is the author’s contribution to that effort. The objectives of this paper are to: (1) put meatpacking competition issues in historical perspective, (2) highlight market structure changes in meatpacking, (3) note some key lawsuits and court rulings that contribute to the historical perspective and regulatory environment, and (4) summarize the body of research related to concentration and competition issues. These were the same objectives I stated in a presentation made at a conference in December 2009, The Economics of Structural Change and Competition in the Food System, sponsored by the Farm Foundation and other professional agricultural economics organizations. The basis for my conference presentation and this paper is an article I published, “A Review of Causes for and Consequences of Economic Concentration in the U.S. Meatpacking Industry,” in an online journal, Current Agriculture, Food & Resource Issues in 2002, http://caes.usask.ca/cafri/search/archive/2002-ward3-1.pdf. This paper is an updated, modified version of the review article though the author cannot claim it is an exhaustive, comprehensive review of the relevant literature. Issue Background Nearly 20 years ago, the author ran across a statement which provides a perspective for the issues of concentration, consolidation, pricing, and competition in meatpacking. “This squall between the packers and the producers of this country ought to have blown over forty years ago, but we still have it on our hands....” Senator John B. Kendrick of Wyoming, 1919. Senator Kendrick no doubt knew that some of these same issues existed since the 1880s. Shortly after his comment, the Supreme Court issued the Packers’ Consent Decree in 1920 and Congress passed landmark regulatory legislation, the Packers and Stockyards Act of 1921, which created the Packers and Stockyards Administration (PSA), later reorganized and renamed the Grain Inspection, Packers and Stockyards Administration (GIPSA), within the U.S. Department of Agriculture (USDA). The consent decree and formation of a regulatory agency in USDA may have quieted the waters for a time but many of the same issues surfaced not too many years later. Results of a study published in a reputable economics journal, which the author first saw 20 years ago, contained the following summarization statement. “Only after considerable further investigation will we know whether or not reform in the packing industry is necessary. It is conceivable that such monopoly elements as exist yield desirable results. A less extreme possibility is that results are 2 undesirable but not sufficiently bad to bother about.” (Nicholls 1940). One could trace what might be referred to as the modern era controversy to the late 1960s when Iowa Beef Processors began to be a major force in the meatpacking industry. Their technological innovation of boxed beef combined with questionable and admittedly illegal market penetration tactics into retail markets had a major effect on market structure and economics of the meatpacking industry. Clear and continuing changes in the structure of the U.S. meatpacking industry have significantly increased economic concentration since the mid-1970s. Figure 1 shows the reported four-firm concentration in steer and heifer slaughter, boxed beef production, and hog slaughter since 1972 based on GIPSA data (Grain Inspection, Packers and Stockyards Administration 2008). These concentration levels will be addressed in more detail later in the paper. Concentration levels are high by many economists’ standards, above levels considered by some economists to elicit non-competitive behavior and result in adverse economic performance. However, several civil antitrust lawsuits have been filed against the largest meatpacking firms with no major antitrust decisions against those largest firms, and there have been no significant Federal government antitrust cases brought against the largest meatpacking firms over the period coincident with the period of major structural changes. 100 90 80 70 t cenreP t 60 50 40 30 20 10 0 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 Steers/Heifers Boxed Beef Hogs Source: GIPSA, USDA Before addressing the concentration data in more detail, let me review the rapid structural changes which occurred in U.S. meatpacking. What economic factors caused the rapid changes and increased concentration? 3 Structural Changes and Causes Structural changes in the beef industry preceded similar changes in the pork industry. This review of structural changes focuses on steer and heifer slaughtering-fabricating and hog slaughtering. In 1976, there were 145 steer and heifer slaughtering plants with annual slaughter of 50,000 head or more (GIPSA 2008 and previous annual reports). These plants slaughtered 22.4 million cattle. Plants with annual slaughter exceeding one-half million steers and heifers annually numbered 5 and accounted for 14.8% of slaughter by all firms in the over 50,000 head per year category. Average slaughter in these largest 5 plants averaged 666,800 head. Comparable data for 2006, the last year data were reported, show major changes. The number of plants in the category of 50,000 head or more per year had declined to 36 but slaughter in these plants increased to 26.0 million head. Fourteen plants each slaughtered one million or more cattle in 2006. These 14 accounted for 70.2% of total steer and heifer slaughter in the 50,000 head or more size group. Average slaughter per plant in the largest plants nearly doubled from 1976. Annual slaughter in the 14 largest plants averaged 1,302,643 head. The same trend is evident also for boxed beef processing plants. Not only did plant size increase, growth and consolidation resulted in larger beefpacking firms as well. There can be little argument that concentration in fed cattle slaughter and boxed beef production is high by economists’ standards. In 1976 for steer and heifer slaughter, the four largest firms accounted for 25.1% of total steer and heifer slaughter (a CR4 of 25.1) according to GIPSA data (Figure 1). By 2007, the four largest firms accounted for 80% of total steer and heifer slaughter as well as 80% of boxed beef production. It should be noted that the four largest firms in 1976 were not the same as the four largest firms in 2007. Mergers and acquisitions were largely responsible for the difference in leading firms. Porkpacking followed a trend similar to beefpacking but changes were not as dramatic. In 1976, there were 141 plants with annual slaughter of 50,000 or more hogs (GIPSA 2008 and previous annual reports). These plants slaughtered 66.0 million hogs and 12 of the plants had an annual slaughter exceeding one million head. Those 12 plants accounted for 28.5% of the total for plants with 50,000 or more hogs slaughtered per year. Average slaughter per plant in the 12 largest plants was 1,569,000 hogs. The number of plants slaughtering 50,000 or more hogs annually declined to 77 by 2006 but annual slaughter increased to 103.5 million hogs. The number of plants slaughtering one million or more hogs annually increased to 28 and their share of total slaughter in the 50,000 head or more size group increased to 89.9%. Average slaughter for the 28 largest plants increased to 3,325,964 hogs. As in the beef industry, growth and consolidation led to larger porkpacking firms also. The four largest hog slaughtering firms in 1976 had a combined market share (CR4) of 32.9%. Note the CR4 for hog slaughter two decades ago exceeded that for steer and heifer slaughter. Since then, the CR4 for hog slaughter has not increased as rapidly as it has for steer and heifer slaughter. 4 However, the CR4 for hog slaughter reached 65.0 in 2006. Again, the largest firms in hog slaughtering in 2007 were not the same as two decades earlier. The sharp trend toward fewer and larger plants was driven by the enhanced economic efficiency and cost management associated with operating larger firms. MacDonald and Ollinger (2005) cite technology combined with a sharp reduction in packer costs as contributing factors for consolidation in beefpacking. Meatpacking is a margin business. Firms buy livestock at a small range around the market average price. Meatpackers do not control the market average price, i.e., the result of price determination, because they neither control supply nor demand; but packers can influence prices paid around that average price level, i.e., the result of price discovery. They sell meat and byproducts at a small range around the market average wholesale price. Again, they do not control the market average wholesale price but can influence prices received around that average price level. Thus, if gross margins are about the same for all firms, the firm with the lowest costs experiences the largest net margin or profit. Therefore, meatpacking firms search for ways to control costs per unit of output as a means of controlling net margins. As a result, one of the driving forces in meatpacking is the need to be a low-cost slaughterer and processor. And one way to achieve lower costs per unit is to operate larger, more efficient plants at near-capacity levels of utilization. The 1980s saw consolidation of packers and plant closings and reopening to control labor costs, a point clearly shown by MacDonald and Ollinger.